Monday, February 8, 2016

More Than You May Have Wanted On "The State of Venture Capital"

From Fortune:

Expect the tortoise to make progress against the rabbit.

There are a lot of data points that one can use to get a sense of the venture capital markets, including the number of startup financings and the level of VC fundraising. They point to some widely known facts: Deal volume and valuations are up massively over the past seven years and non-VC money has entered the system.

But these data points are often lagging indicators. Perhaps a better barometer would be to gather data on VC perceptions in the market right now. Of course sentiment can swing wildly with new information, but I set out to take the pulse of the market as we enter 2016.

State of the Market

Let’s start with some basic data most people know. Limited partners (LPs) who invest in VC funds have continued to pour money into venture – with the market returning to pre-recession levels.

Don’t be fooled by the slight dip in 2015 ― the size of funds and the timing of deals in any year can skew the data set. LPs tell me that 2016 is one of their busiest calendars in years and, unless we see a unexpected downturn, expect the market size in 2016 to remain at current levels or increase.

How do I know? We surveyed 73 LP firms to get their views on the market. While the data from LPs makes it clear that they have concerns about the pace by which VC firms will invest, 82% said they expected to keep the same pace, with 8% suggesting they would increase investments. I would also point out that with corporates investing in more VC funds and Chinese money looking for stability, it’s entirely possible that brand new money enters the system.

But LP dollars into VC isn’t really “the story” ― the biggest shift in the past decade is the amount of “non-VC” investment that has gone into venture-backed tech startups. Let’s start with the money slide:

Ten years ago there was about the same amount of money pouring into VC as found its way into startups. But, in the past two years, 2.5 times the dollars went into venture-backed startups as went the money that poured into VC. This isn’t an “emptying out of the VC coffers” but rather new participants pushing their chips onto the table with relatively less experience at doing so.

The result? Median pre-money valuations skyrocketed ― shooting up 3x in just three years as investors competed to christen imaginary animals with imaginary valuations. And then, seemingly all at once, the market felt constipated.

Sentiment of the Market

So what happened?

As I’ve argued for ages there has to be a correlation between public tech stock valuations and private market valuations. Of course this doesn’t mean private market valuations will follow the same P/E or P/S ratios, since the expectation is for much higher growth rates in private companies. But the correlation became completely untethered in the past 3 years.

So why the slow down all of a sudden? Leaving aside China, oil prices, Syrian refugees, a presidential election and all of the things that might feed into general market fear – this chart is telling

Frankly, it’s really hard to write checks at later-stage valuations when you know you’ll have to exit into the public markets or sell to a public-market company, and the stocks are declining precipitously....MUCH MORE